"the government may conclude that full nationalisation of Royal Bank of Scotland isn't necessarily worse than the status quo."

Peston in the morning on BBC:

"It's more than a little local difficulty that Royal Bank of Scotland yesterday suffered the indignity of becoming a penny stock (though it's bounced a bit this morning).

Because of the plans for global domination of its previous chief executive, Sir Fred Goodwin, this bank is known from Wall Street to Shanghai.

It's big in America. It had till recently a symbolically important stake in Bank of China. It was the victor in the world's biggest ever cross-border banking takeover battle, when it acquired the poisonous rump of ABN Amro (but not "ANB Ambro," as Gordon Brown put it, when scolding Royal Bank yesterday).

Whether we like it or not, the collapse in its value from more than £70bn a couple of years ago to £4.6bn represents unfortunate worldwide advertising about the perceived frailties of our financial system and our economy.

In the context of how others see us, here are remarks made overnight by Jim Rogers, the well-known investor, to Bloomberg: "I would urge you to sell any sterling you might have...It's finished. I hate to say it, but I would not put any money in the UK."

Errr, say what you mean Jim.

Inevitably, sterling has fallen - to its lowest level against the Yen since 1971 and to its lowest against the US dollar since March 2002. For what it's worth, Rogers believes sterling will approach parity with the dollar.

The connection between sterling and the health of our banking system goes like this.

Our banks have colossal overseas liabilities; they've borrowed huge sums abroad. According to Bank of England figures, the gross foreign currency liabilities of British banks are around £4,400bn (having quadrupled over a decade).

Of course the banks all have matching assets. But the problem is that the assets tend to be illiquid, hard to sell. Whereas the lenders to the banks can often ask for their money back at relatively short notice. ( THIS IS A CALLING RUN )

The reason that Royal Bank of Scotland and HBOS - now part of Lloyds - were semi-nationalised in October was that lenders to them were demanding their money back( THE CALLING RUN ). They were hours from collapse and it was therefore vital that the British state should be seen to be standing firmly behind them( TOTALLY GUARANTEEING THEM ), to reassure all lenders to them that their funds were safe( THIS IS THE ONLY WAY TO STOP A RUN ).

But when the Treasury acquired big stakes in Royal Bank and what's now called Lloyds Banking Group - and when it committed £500bn of loans and guarantees to make sure that all the big banks could repay providers of wholesale loans that could demand their money back - at that point the liabilities of the banks increasingly came to be seen as the liabilities of the state( TRUE ).

This is not an accounting issue of whether Royal Bank's £1,900bn of liabilities is on the public-sector balance sheet.

It's about whether, when it comes to the crunch, the state would honour those liabilities( THEY HAVE TO BE BELIEVED IN ORDER FOR THE GUARANTEE TO WORK ).

And, of course, we all know that the Treasury would honour those liabilities. The damage to the British economy of allowing a bank like Royal Bank to renege on what it owes would be unthinkably huge( TRUE ).

So it matters, in the first instance, that our banks are perceived as viable, profitable businesses - able to pay their way( TRUE ).

And it also matters, in the second instance, that the UK state is viewed as being able to honour the liabilities of its banks, in the unlikely event that a mob of overseas lenders to the banks all asked the teller one day for their money back( THE CALLING RUN. YES. EXACTLY. ).

What this means is that if you put any kind of probability on a recurrence of the collapse in confidence in our banks that we saw in October, then some portion of banks' overseas liabilities should be counted as an increment to the ballooning debts of the government - which is why there's a link between the perceived weakness of the banks and a fall in sterling.

Although - as you'll have spotted - there's a dreadful paradox: a fall in sterling actually makes the problem worse. Because, as Royal Bank of Scotland helpfully pointed out in its trading update yesterday, a fall in the pound increases( DEBT-DEFLATION ) the sterling value of banks' overseas assets and liabilities.

All of which is to explain why, in these febrile circumstances, something as nebulous as "confidence" in our banks really matters( VERY TRUE. IT'S ESSENTIAL. ).

In that context, what may count is that investors yesterday believed that short-sellers were once again driving down the value of bank shares - even though I am reliably told there was very little short-selling.

That fear of short-selling may have persuaded other investors to dump bank shares, or given them a further reason to do so. Which is why the lifting of the ban on short-selling of financial stocks last Friday may have been unfortunately timed.

Also, as I said last night on the Ten O'Clock News, the prime minister' may have meant well when giving a stern instruction to the banks that they must come clean about the scale of their dodgy assets. But it unnerved shareholders, who wondered on what basis they could value banks, if even the most powerful man in the country didn't know what horrors lurk inside them( THIS IS TRUE, BUT THERE IS A DIFFERENCE BETWEEN THE VALUE OF BANK STOCKS AND THE OVERALL MARKET. ).

As for the lack of detail in the multi-hundred-billion pounds plans announced by the Treasury to stimulate lending, that was an invitation to the City to fear the worst - to conclude that the banks would become profitless instruments of the state( FOR A TIME THEY WILL. BUT, AGAIN, WHAT'S BAD FOR BANK STOCKS CAN BE GOOD FOR THE OVERALL MARKET. ).

Where does all this lead?

Well if the world's investors already see Royal Bank as a de facto part of the state, if the constant noise about its future in the City and the media is damaging to wider confidence in the financial system, then the government may conclude that full nationalisation of Royal Bank of Scotland isn't necessarily worse than the status quo."( I'M AFRAID THAT'S TRUE. )